11/ 29/ 2006
by Kay Bell
Time is running out, but you still can make some moves to reduce your impending tax bill
The tax clock is ticking. You have only a few weeks left to make tax moves that could save your company money. But there's still plenty of time to save if you know where to look in the tax code.
Many small businesses don't operate as corporations. Rather, they are proprietorships, partnerships or S corporations in which the business' tax consequences are passed along to the individual taxpayer.
Many companies choose S corp status because its earnings are not considered salary, allowing the individual filer to avoid significant payroll taxes. That's logical, says Steven I. Hurok, CPA and a tax director at BDO Seidman, LLP in Woodbridge, N.J., but it doesn't always pass the IRS test. The tax agency expects you to pay a fair salary for your work, along with payroll taxes.
"How much of your earnings should be considered salary? It's a judgment call," Hurok says. "The IRS point of view is that this has been abused. So before the end of the year, evaluate and come up with an amount that is appropriate."
Defer and deduct
Regardless of a company's operating structure, the business tax-reduction rule of thumb is to defer income. But you might want to rethink that a bit.
"It's probably fair to say that post-election tax rates are not likely to go down," Hurok says. "If you're concerned that tax rates might go up in some form, you don't necessarily want to defer too much of the income."
It's a tough call, but one to consider in light of your company's 2006 situation and your forecast for future earnings.
Then there are deductions.
An oldie but goodie is writing off equipment purchases. Known as section 179 expensing, a business can deduct capital expenditures of up to $108,000 on 2006 returns on equipment bought by Dec. 31.
Be sure, though, that your write-offs do not exceed your income amount. "You can't just write off to create a loss," Hurok says. And if your costs exceed $430,000 this year, the amount in excess of that figure must be used to reduce your allowed deductions. "If you bought $450,000 in capital equipment, you're over by $20,000," Hurok notes. "Your annual deduction then goes down $20,000, so you'd only get $88,000 as a write-off."
A sometimes overlooked tax break is one that took effect in 2005 and is designed to reward companies that follow the "Made in the U.S.A" motto. Eligible U.S.-based businesses can claim a deduction for manufacturing products domestically rather than sending the work overseas.
On 2006 returns, the domestic production activities deduction offers a break of 3 percent of your taxable income. "You have to make income, but there is no expenditure of cash required," Hurok says. "The expenditure is in the accounting effort to arrive at the cost of the production." The write-off's rules are somewhat complicated, which probably explains why it is underused, but the savings could more than pay for the cost of hiring a tax accountant to help decipher it.
Doing away with bad debts
As you finalize your business' year-end books, pay close attention to outstanding debts. They could offer a tax break.
If you have debts or payables that are still out, you can write them off and take a deduction for the amount. The key is to genuinely no longer try to seek collection. "Some people are always eternal optimists, thinking someday they might get paid," Hurok says. "You might be better off conceding the fact, ceasing collection efforts and taking the deduction."
Similarly, if you have an inventory that's not selling and just sitting in warehouse, Hurok says it might be more tax valuable as junk. By disposing of it, you can claim a product's value as a deduction.
Again, you must actually do away with the product. Hurok recommends taking date-stamped digital photos of the inventory and the disposal process. Such photos should satisfy any potential IRS questions about the deduction. Hurok notes that the disposal counts as a business loss, meaning there is no limit on the amount that can be claimed. You deduct it in the year you abandon the product.
Another deduction area is state taxes, which Hurok says tend to be on the high side. "Many people pay the fourth quarter [estimated taxes] in December and get a [federal] deduction for it," he says.
However, Hurok advises business filers to be aware of potential unexpected results that could come up in connection with deductions, especially if the business is one in which income flows through to the individual for reporting on personal returns. The major concern: the alternative minimum tax. Under this parallel tax system, many tax breaks are disallowed. So when figuring your business deduction strategy, keep possible AMT problem areas in mind so you can avoid them or at least be prepared.
Retirement planning
Finally, look to the future for a tax break now. Utilization of a company retirement plan will let you plan for retirement and offer current tax year savings.
You have until Dec. 31 to open a Keogh plan. If you already have a company retirement plan, make payments to it as soon as possible.
In addition to helping reduce your 2006 business tax bill, the sooner you put the tax-deferred money away, the more time it has to grow into a sizeable nest egg.
